Weekly Musings – CME Fedwatch change for week to July 12, 2024

13 Jul 2024 , 09:31 AM

US INFLATION FINALLY SEES A SHARP FALL

That was the one signal that the US Fed had been waiting for. In the last few weeks, the Fed had been overly concerned that the inflation was stagnating and the last mile was proving to be very difficult. Finally, there is good news in June, with the consumer inflation falling by 30 bps to 3.0%. This was driven by a sharp fall in the energy inflation, which had been the bane in the last 6 months. Food inflation was slightly higher in the US in June, but to compensate for that, core inflation tapered by another 10 bps, keeping overall inflation in check. The table below captures the break-up of inflation, and this bodes well for PCE.

Inflation Basket Category	Jun 2024 (YOY)	May 2024 (YOY)	Inflation Basket Category	Jun 2024 (YOY)	May 2024 (YOY)
Food Inflation	2.20%	2.10%	Core Inflation	3.30%	3.40%
Food at home	1.10%	1.00%	Commodities less food and energy	-1.80%	-1.70%
·          Cereals and bakery products	0.50%	0.70%	·          Apparel	0.80%	0.80%
·          Meats, poultry, fish, and eggs	2.60%	2.40%	·          New vehicles	-0.90%	-0.80%
·          Dairy and related products	-0.10%	-1.00%	·          Used cars and trucks	-10.10%	-9.30%
·          Fruits and vegetables	-0.50%	0.60%	·          Medical care commodities	3.10%	3.10%
·          Non-alcoholic beverages	1.50%	1.30%	·          Alcoholic beverages	1.80%	1.70%
·          Other food at home	1.60%	1.00%	·          Tobacco / smoking products	8.20%	7.80%
Food away from home	4.10%	4.00%	Services less energy services	5.10%	5.30%
·          Full service meals and snacks	3.90%	3.50%	Shelter	5.20%	5.40%
·          Limited service meals	4.30%	4.50%	·          Rent of primary residence	5.10%	5.30%
Energy Inflation	1.00%	3.70%	·          Owners’ equivalent rent	5.40%	5.70%
Energy commodities	-2.20%	2.20%	Medical Care Services	3.30%	3.10%
·          Fuel oil	0.80%	3.60%	·          Physician Services	0.80%	1.40%
·          Gasoline (all types)	-2.50%	2.20%	·          Hospital Services	6.90%	7.20%
Energy services	4.30%	4.70%	Transport Services	9.40%	10.50%
·          Electricity	4.40%	5.90%	·          Motor vehicle Maintenance	6.00%	7.20%
·          Natural gas (piped)	3.70%	-0.20%	·          Motor vehicle insurance	19.50%	20.30%
Headline Consumer Inflation	3.00%	3.30%	·          Airline Fare	-5.10%	-5.90%

Data Source: US Bureau of Labour Statistics

What are the key takeaways from the break-up of inflation above?

• For starters, the food inflation is marginally higher by 10 bps in June 2024 at 2.2%, compared to 2.1% in May 2024. What has driven the food inflation higher in June? Meat & Poultry, Dairy Products and non-alcoholic beverages are among the big contributors to the rise in food inflation in June 2024. However, this has also been partially compensated by a tapering of inflation in cereal preparations, fruits, and vegetables.
• Core inflation continued its downward journey falling another 10 bps from 3.4% to 3.3% in the month of June 2024. What were the triggers for the fall in core inflation? Used cars, rentals, car insurance and car maintenance were the items that pushed core inflation lower. However, core inflation was partially boosted by items like tobacco products, physician services, hospital services and airline fares.
• The big story of the June month was the sobering of energy inflation which fell from 3.7% in May 2024 to 1.0% in June 2024. The big fall in energy inflation was driven by a drop in the prices of fuel oil, gasoline oil and electricity services; while the prices of piped natural gas went up sharply. Overall, the sharp fall in the energy inflation was the singular factor that drove the overall headline inflation in the US lower for June.

One can argue that a few swallows do not make a summer. The Fed would most likely also look at July and August Data and then take a view in the September Fed meeting. If the inflation data does not worsen too much from here, the Fed should be on target for its first rate cut in September this year.

RECAP – CME  FEDWATCH FOR THE WEEK ENDED JULY 05, 2024

Let us start with a recap of the week to July 05, 2024; and how the CME Fedwatch panned out during the week. By the week to July 05, 2024, the markets had more or less crystallized that the first rate cut would happen by September 2024 and that there was a high probability of two rate cuts by the end of 2024. Her are the CME Fedwatch probabilities.

Fed Meet	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	7.8%	92.2%	Nil
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	5.9%	72.0%	22.1%	Nil
Nov-24	Nil	Nil	Nil	Nil	Nil	2.5%	33.8%	50.9%	12.8%	Nil
Dec-24	Nil	Nil	Nil	Nil	2.0%	27.3%	47.3%	20.8%	2.7%	Nil
Jan-25	Nil	Nil	Nil	1.4%	19.3%	41.0%	29.1%	8.3%	0.8%	Nil
Mar-25	Nil	Nil	1.0%	14.0%	34.6%	32.6%	14.5%	3.1%	0.2%	Nil
Apr-25	Nil	0.5%	7.4%	24.2%	33.6%	23.6%	8.8%	1.7%	0.1%	Nil
Jun-25	0.3%	5.0%	18.4%	30.4%	27.1%	13.9%	4.1%	0.7%	Nil	Nil
Jul-25	2.2%	10.2%	23.0%	29.1%	22.0%	10.2%	2.8%	0.4%	Nil	Nil
Sep-25	10.1%	20.1%	27.7%	23.6%	12.9%	4.5%	1.0%	0.1%	Nil	Nil

Data source: CME Fedwatch

The big story of the week was the FOMC minutes published on July 03, 2024; and that only underscored the rather ambivalent approach of the Fed.

• The first big trigger for the week to July 05, 2024 was the minutes of the Fed meet published on July 03, 2024. Incidentally, the Fed continued to be ambivalent; more because it could afford, and less because it had to. The consensus was that rate cuts would be limited to just one rate cut in 2024 and possibly more aggressive cuts in the coming year. On the positive side, FOMC members unanimously agreed that the US economy had made substantial and perceptible progress on curtailing inflation without hitting GDP growth. However, FOMC member continue to be on wait and watch mode.
• Addressing a gathering in Lisboa; Fed Chair Jerome Powell spoke about the balancing of risks in policy decision making. According to Jerome Powell, the risk for a long time was choosing between cutting rates too soon and cutting rates too late. On the optimistic side, he admitted that the risk had come down. In fact, according to Powell, the risk of now being too early had reduced considerably. That shows rate cuts are in the offing.
• Crude oil inventories were the big shocker during the week to July 05, 2024. Bloomberg estimates had pegged a drawdown on API crude oil inventories to the tune of -0.400 Million barrels in the week. However, the actual drawdown for the week was a steeply higher figure of -12.157 Million barrels. That led to sharp spike in oil prices globally, as Brent scaled above $87/bbl. That had put some pressure on the energy inflation.

Having set the basis for the discourse with the previous week’s data, let us turn to how the triggers for inflation panned out in the week to July 12, 2024; which is the recent week.

CUT TO PRESENT: CME FEDWATCH IN WEEK TO JULY 12, 2024

The latest week to July 12, 2024 saw the CME Fedwatch continue to factor in 2 rate cut in 2024. However, the lower than expected consumer inflation triggered a hope that the Fed rate cuts could be surer, sharper, and also more decisive.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.2%	93.8%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	6.0%	90.3%	3.8%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	3.6%	56.3%	38.6%	1.5%
Dec-24	Nil	Nil	Nil	Nil	Nil	3.2%	50.6%	40.5%	5.5%	0.2%
Jan-25	Nil	Nil	Nil	Nil	2.3%	37.8%	43.2%	14.9%	1.6%	Nil
Mar-25	Nil	Nil	Nil	1.9%	30.8%	42.2%	20.6%	4.3%	0.4%	Nil
Apr-25	Nil	Nil	1.1%	18.6%	37.4%	29.7%	11.1%	2.0%	0.2%	Nil
Jun-25	Nil	0.8%	13.5%	31.9%	31.9%	16.5%	4.6%	0.7%	Nil	Nil
Jul-25	0.3%	6.5%	21.8%	31.9%	25.0%	11.2%	2.9%	0.4%	Nil	Nil
Sep-25	5.9%	19.6%	30.5%	16.0%	13.1%	4.0%	0.8%	0.1%	Nil	Nil

Data source: CME Fedwatch

The biggest trigger in the latest week was the announcement of CPI inflation, and it came in sharply lower by 30 bps. Here are some key data points for the week.

• The CPI inflation for June 2024 came in sharply lower at 3.0% compared to 3.3% for May 2024. The sharply lower consumer inflation was led by a sharp fall in the energy inflation, which was a fall across fuel oil, gasoline, and electricity, although piped natural gas prices were up. Although the oil prices in the Brent crude market stayed above $85/bbl, the higher base effect helped the energy inflation to taper in the month.
• Testifying before the US Congress on July 10, 2024, Jerome Powell said that the Fed would continue to remain focused on its dual mandate of stable prices and maximum employment. Powell also added that the risks to achieving these goals had come down substantially due to the hawkish stance of the Fed. That hints at the Fed now being open to rate cuts in September, if not in the July 2024 FOMC meeting.
• The figure of initial jobless claims in the week came in at 222K, compared to the expected figure of 239K, which means less people are filing for unemployment insurance and that is a sign of a strong US economy. The other risk to inflation in the recent week was the US oil inventories once again seeing a sharper than expected drawdown..

Let us now turn to the all-important aspect of the key triggers for the CME Fedwatch in the coming week; and what could really impact the Fed rate cut probabilities.

TRIGGERS FOR CME FEDWATCH: NEXT WEEK TO JULY 19, 2024

The next week has some important triggers but the focus will be more on specific data flows and the speeches delivered by the Fed governors.

• Ahead of the third and final estimate of Q1 GDP by the US Bureau of Economic Analysis in the last week of July, the Q2 estimate of Atlanta Fed GDP assumes significance. The street is expecting 2.0% GDP growth in Q2, which is where the estimate was last week also. The signals are that Q2 could be better than Q1, in terms of GDP growth.
• API crude stocks would once again be in focus as energy inflation continues to be the major topic for discussion. Last week, the API crude inventories had seen drawdowns of -1.923 Million barrels, which was substantially higher than the street estimates. The drawdowns are expected to continue this week, but the size would be of relevance.
• Apart from Fed Chair, Jerome Powell who will be speaking in this week, there are a number of other important voices also to watch out for. The markets would be closely tracking the speeches of Mary Daly, Christopher Waller, Michelle Bowman, John Williams, and Raphael Bostic who are expected to speak in the coming week. Their words will be tracked for hints of September 2024 rate cuts.

Let us now turn to the final story of how all these flows added up to influencing the CME Fedwatch probabilities in the latest week.

CME FEDWATCH – MORE CONFIDENT OF SEPTEMBER RATE CUT NOW

The CPI inflation falling sharply from 3.3% to 3.0% in the month of June was a big trigger for the Fed to closely consider rate cuts in September. This week we have seen some of the probabilities of rate cuts sharpening in the CME Fedwatch. Here is a quick dekko at how the rate cut probabilities have panned out at the end of the current week.

• With rate hikes virtually ruled out for now, we will focus on rate cut probability in 2024 first. Currently, the CME Fedwatch has assigned a 96.2% probability that the first rate cut will happen in September; sharply higher than 78% last week. For now, July rate cut has a probability of just about 6.2%; which is insignificant. However, by December 2024, the CME Fedwatch is pencilling in a 94.3% probability of 2 rate cuts; sharply higher than the 76.5% probability last week. Both probabilities are up sharply over last week.
• What about the CME Fedwatch expectations stack for 2025? By July 2025, the CME Fedwatch is factoring in 96.7% probability of 4 rate cuts, sharply higher than 86.6% probability as of last week. In addition, the CME Fedwatch is also assigning a probability of 95.1% probability of 5 rate cuts by September 2025. These probabilities will evolve more realistically once the Fed embarks on its first rate cut this year.

For now, the Fed can afford to maintain status quo. The question is whether the Fed will bite the bullet and cut rates, if there is tearing urgency for the same. We have to find out!